What does the term 'interest' refer to in finance?

In finance, 'interest' refers to the cost of borrowing money or the earnings on investments. This concept is fundamental to understanding how loans work as well as how investment returns are generated. When individuals or businesses borrow money, lenders charge interest as a fee for the service of providing those funds, which is typically expressed as a percentage of the principal amount borrowed. On the other hand, for investors who utilize savings accounts or bonds, interest is the return they earn on their investments over time, which reflects the reward for tying up their capital.

This dual nature of interest makes it a crucial element in personal finance, affecting decisions related to loans, mortgages, savings, and investments. It ties directly into concepts like the time value of money, where the value of money changes based on interest rates over time. Understanding interest helps individuals make informed choices about borrowing and investing, as well as how to manage and optimize their personal finances.